By Debora Peters
Businesses will face so many challenges when tax time rolls around in January 2015. I have heard a lot of opinions surrounding the dilemma of Internal Revenue Code Section 280E for cannabis business activity.
To put it in a nutshell, if you are involved in an activity that is considered illegal at the federal level, you need to know the dos and don’ts for federal tax purposes. For goodness sake, if something sounds too good to be true — it probably is.
• IRC 280E states there will be a disallowance of ordinary and necessary business deductions.
• No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of Schedule I and II of the Controlled Substance Act) which is prohibited by federal law or the law of any state in which such trade or business is conducted.
Although the Internal Revenue Service has issued strict guidance for enforcing 280E and disallowing ordinary and necessary business expenses, it has also stated that a deduction for the cost of goods sold will be allowed.
Cost of good sold is not a deduction within the meaning of Section 162(a) but is subtracted from gross receipts in determining a taxpayer’s gross income.
By allowing the cost of goods sold deduction, a taxpayer would be able to reduce their gross income, received by certain qualified cost of goods sold expenses and only taxed on the gross profit.
There is not a definitive list of what is considered within the cost of goods sold; this list seems to vary based on the industry. Below is a list of the most common cost of goods sold expenses:
• The cost of products or raw materials;
• Freight or shipping charges;
• The cost of storing products the business sells;
• Direct labor costs for workers who produce the products;
• Factory overhead expenses.
Deductions are strictly a matter of legislative grace.
As a business owner/operator, the burden of proof falls on you. The key to success is contemporaneously kept books and records, as well as record retention. Statutes of limitations generally limit the time the IRS has to make tax assessments (audit) to within three years after a return is due or filed, whichever is later. That particular date is also referred to as the statute expiration date.
If you are a retail shop, you are going to be faced with the additional challenges of selling paraphernalia, which is not on the controlled substance list, and therefore would be allowed a deduction for ordinary and necessary business expenses.
Due to the complexity of this topic, I will address it specifically in next month’s issue.
I would recommend seeking qualified professional guidance when setting up your accounting software and planning how you will be conducting your day-to-day operations.
Debora D. Peters, of Peters Tax Solutions LLP, is an accredited tax preparer who has represented hundreds of clients under federal and state audits. She obtained her Enrolled Agents License in January 2009.